Abercrombie & Fitch – A Speculative Stock

Shares in Abercrombie & Fitch fell by 27% this week after announced it has terminated discussions on a potential sale of the company.

Is this a buying opportunity?

About the Company

Abercrombie & Fitch (A&F) is an American retailer that focuses on upscale casual wear for young consumers, its headquarters are in New Albany, Ohio, a suburb of Columbus. The company operates two other offshoot brands: Abercrombie Kids & Hollister Co.

What is attractive about the shares?

The first five arguments which come to mind and make this stock look attractive at the current valuation are as follows:

1. Shares of Abercrombie & Fitch fell 27% after the news that the company has terminated discussions on a potential sale of the company. (The potential buyer being a joint venture between American Eagle (AEO) and Cerberus.)

2. There are several signs that the situation is improving, from ongoing strength at Hollister to less negative comparisons at Abercrombie

3. The stock is trading at depressed multiples and offers an 8.6% dividend yield

4. Abercrombie has a net cash position and is arguably in a better position to turn itself around than if it had been burdened with takeover debt

5. Abercrombie could spin off its faster-growing Hollister brand and shut down its namesake stores entirely to re-emerge as a wholesale brand

6. Another company could be interested in making an offer to buy Abercrombie at a more attractive price for shareholders

Why did the potential buyer back out of the deal?

The management shared its view that there is no need of an outright sale and expressed optimism for the prospects of both its divisions:

‘We believe in the prospects for our business and the opportunities for our brands. We are generating solid comp store sales momentum at Hollister and continue to refine and implement strategies to position the Abercrombie brand for revitalized performance.’

Shares are looking attractive

After the strong sell-off, Abercrombie & Fitch is trading on a depressed valuation that implies a lot of upside potential, if things start to work well. There are not many stocks trading at these valuations and with Abercrombie's financial characteristics. ANF offers a 8.6% dividend yield that is backed by a solid balance sheet with $420 million in cash and a current ratio of 2.4x.

EV/EBITDA is below the industry multiple

EV/EBITDA is a financial metric often used by buyers to assess the reasonability of a target's valuation.

The stock is trading at just 3.2x EV/EBITDA, a below-industry multiple that suggests expectations of a perpetual decline. Even if the company managed only to report flat sales, I think the market's reaction would be quite strong. I think the conditions for an investment in ANF are becoming more favorable.

Risks

• Operating performance at Abercrombie could not improve or not improve as fast as expected

• A dividend cut might be needed if the company wants to avoid deterioration in the balance sheet

Conclusion

Abercrombie & Fitch is just in the gray area between the fashion companies. On one side, Hollister is performing well and above the industry average. On the other side, Abercrombie continues to post double-digit declines. Nonetheless, in the past management has demonstrated their ability to successfully manage turnarounds. A stock worth considering as a speculative buy.